Why Saudi Arabia Will Not Win The Oil Price War

US producers aren’t going to just give up.

Crude oil prices continued to surprise on Tuesday, with the U.S. benchmark adding another 4 percent to $44.60 a barrel. West Texas Intermediate is now up 65 percent since hitting 13-year lows below $27 a barrel February 11. It’s a performance only bettered by the globe’s second most traded bulk commodity – iron ore.

But like analysts of the steelmaking raw material, many in the industry have been surprised by the extent of the rally, consistently calling the oil price lower. The blame for the cloudy outlook for crude is mostly being laid at the door of Saudi-Arabia.

After the collapse of the Doha talks to freeze production and amid a spat with the U.S. over terrorism, the world’s top producer has threatened a scorched earth policy when it comes to maintaining and growing its market share.

But there is an alternative view out there that argues that the U.S., more than the Saudis, will control the direction of the market and in the event of an all-out price war holds the commanding position.

That’s thanks to astonishing technological improvements in the U.S. The shale revolution that drove natural gas production between 2010 and 2015, found its way into the oil field, resulting in a 57 percent jump in U.S. crude production in just three short years to peak at 9.7 million barrels per day in April 2015.

And it’s not just a crude story: In the last decade, the U.S. has introduced 8.3 MMBoe/d (million barrels of energy equivalent per day) into the global market when one considers production of crude, natural gas and natural gas liquids according to research by Platts Analytics.

Suzanne Minter, Manager of Oil and Gas Consulting for Platts Analytics on Tuesday testified before the U.S. Senate Energy and Natural Resources Committee about where the global oil market is heading.

Minter said “the time and the rate in which this energy entered the market appears to have stressed the system in ways unimagined” making the U.S. producer “the marginal supplier and price setter into the global market”:

“After 14 months of persistently low prices, U.S. producers have entered 2016 with estimated capital expenditures cuts of 40 percent, more than 6,500 drilled but uncompleted wells in inventory, and find themselves operating at or near cash costs.

“Drilled but uncompleted wells hold reserves that can be brought on line in a short period of time, thereby defining the concept of spare capacity. It is plausible to believe that U.S. spare capacity may be close to rivaling OPEC’s current spare capacity. However, we believe that the prices needed to incentivize the U.S. producer to complete their drilled but uncompleted wells may be much lower than global competitors believe or would like it to be.

“The near term oil recovery will be more than likely be tenuous and ebb and flow, rather than occur in a linear fashion, as all parties involved figure out how to balance supply growth. However, due to spare capacity and the unique economic environment which drives producer activity, it may very well be that the U.S. producer is best positioned to lead the recovery and bolster economic growth.”

Platts Analytics research shows that Texas alone could introduce 1.25 MMB/d of oil into the global market and can do so in a short space of time – on average just 30 days. That’s more oil than the Saudis have threatened to flood the market with and all very close to the world’s top refining hub.

Over and above resources and technology, the U.S. has another powerful advantage: dynamic markets. The country has roughly 9,000 different entities producing energy. Saudi Arabia’s oil wealth – indeed its whole economy – is now in the hands of a 30-year old prince.

Minter said that “while each producer will behave differently than the next, it seems realistic pricing in the mid-$40 to $50 per barrel range they will bring incremental volumes back into the market place. Well, that’s where we got to today.”

Wolf here: What this means is that production in the US will rise again, now with oil at $45…. Drillers are already hedging maniacally – so that they can sell future production at this price when the price drops again.

So the pain and the glut will continue far longer than anyone expects. See US natural gas, where this has been happening since 2009.

And Wall Street is feeding the glut with new money. There are already billions flowing back into drilling via “distressed asset” investments (entire funds have sprung up to plow money into this), asset purchases, bankruptcy DIP financing, restructurings, etc. Old investors get wiped out, new investors line up…. The beauty of ZIRP. Happening right now before our very eyes.

32 comments for “Why Saudi Arabia Will Not Win The Oil Price War”

Financiers are working against themselves as usual. They push the price of crude while their customers cannot even afford a lousy stinking iPhone 4. Finance operators don’t pay attention to the ‘little people’, why should they? They don’t Summer in the Hamptons, eat @ fancy restaurants or drive Ferraris.

Regardless of what the futures’ traders, speculators, spot market manipulators, tanker brokers, OPEC and the frackers do, the customers will still be broke. In fact, they are getting broker. If (when) there are oil shortages — absolute shortages rather than relative variety as is the case right now — the hapless customers will be broker still.

Seems to indicate, as many people thought at the time, the oil shocks of the 70s had nothing to do with supply:demand or Arab oil embargo, and everything to do with market manipulation and domestic price gouging. The current shale oil bust appears to have fat more to do with the major domestic oil companies attempts to maintain their cartel than any thing else.

Thomas Malthus

Apr 27, 2016 at 8:47 pm

The lower prices go the more everyone will pump because they need the cash flow to remain in business — waiting on the recovery in oil prices that can never come because high oil prices destroy economic growth.

mosfet

Apr 27, 2016 at 9:52 pm

Supply = High
Demand = Low
Markets = Extreme speculative bubble

Is there something I’m missing? My guess is that, as with every popping bubble, fundamentals tend to force their way back into reality no matter how unwelcome.

Ask yourself what was happening to oil as markets were plummeting in January, and whether the over supply of crude has lessened or increased since then?

Stavros H

Apr 28, 2016 at 3:59 am

You are missing quite a lot. First of all, demand is currently extremely high. In the US, China, India and the Middle East. There is indeed an oversupply of oil globally but it seems to be getting smaller. US oil production has fallen by more than 700K barrels per day from its 2015 peak. That is a massive drop in a very short period of time. This shrinking in US production can only be reversed by a massive rise in oil prices, which is not coming this year. The glut may get worse if the Saudis and the kuwaitis can indeed deliver on their threat and increase production by a million barrels per day in the coming months. This remains to be seen. The Iranians have indeed come good on their claims as they have managed to rump up production in a very rapid way. Lots of Western “experts” were telling us that Iran would require considerable time and tens of billions of dollars in investment in order to reach its pre-sanctions levels of production. The way I see it, there will only be a serious and permanent recovery in the oil price once the current low price environment has seriously dented not only US shale, but most other high cost producers as well. Be them Canadian tar sands, African offshore, Latin America offshore and the North Sea. This will take us into 2018.

Petunia

Apr 28, 2016 at 10:11 am

Read in my local paper yesterday that a regional employer that makes rail cars is laying off about a third of their employees due to the lack of demand. The new rail cars mostly carry oil and the lack of demand has affected production.

mosfet

Apr 28, 2016 at 8:45 pm

The decrease in US oil production is a direct result of drillers drastically cutting rig count to reduce costs, to weather the oil glut. Nat gas producers did exactly the same thing and look what it did for prices there.

Also WTi will be always be forced to loosely follow Brent so US oil producers don’t have the luxury of living in a bubble (short of imposed tariffs & an ensuing trade war). Oil prices are currently in a speculative bubble and the bottom is far from ‘in’.

This article appears to be a last desperate attempt to sucker a few more desperate investors into putting their money into the fracking sink hole. Reminds me of the nonsense that Occidental was claiming about the Monterey shale a couple years ago — reserves were exaggerated and the scam was revealed when a government study reduced the recoverable reserves to only 4% of the claims. The frackers are running out of time and $$$ — the bubble has popped and they can’t meet their debt payments. Expect the oil bankruptcies later this year to start piling up as the fracked well production plummets. The time constant is about a year for a fracked well then product drops like a rock. Without product, they can’t make their debt payments — and they go belly up unless they find some suckers to provide new funds – adios to that money.

Stavros H

Apr 28, 2016 at 4:24 am

That is broadly correct. What most people fail to realize about the oil industry is that price only has a delayed effect on production. The current oil price will have serious effects on global oil production for years down the line. A good rule of thumb is that oil production reflects the oil price three years down the line. This is about far more than just US shale. There are other high cost producing regions out there. Canadian tar sands are even more high cost than US shale and they are the more likely target for the Saudis and the rest of the GCC gang. The difference is that heavy oil production takes more time to decline, but decline it will. On top of that you can add the North Sea, African offshore and Latin America offshore etc etc. My guess is that the oil price stays relatively low throughout 2016 and maybe even 2017. After that we will be looking at massive oil shortages and a price of well over 100 bucks per barrel. Of course this forecast can change via political Fiat, some regional or political crisis in any of the major producers etc. My point is that the low oil price will ultimately have its very serious effect on global production.

walter map

Apr 28, 2016 at 5:59 am

Good.

It is easy enough to suppose that Mr. Richter posted this article just to see if his readers are paying attention, contrasting as it does with other his recent posts on oil-related issues.

I think you missed the point. The point is that production in the US will rise again now with oil at $45….

And guess what? the pain and the glut continue far longer than anyone expects.

And Wall Street will support it with new money. There are already billions flowing back into fracking via distressed investments, asset purchases, DIP financing, restructurings, etc. Old investors get wiped out, new investors line up…. The beauty of ZIRP. Happening right now before our very eyes.

Stavros H

Apr 28, 2016 at 8:51 am

That US shale production will immediately be boosted once the WTI index hits 45 is just a claim thrown around in the MSM. Is there any empirical proof of it? I think not. In fact the current fall in US oil production has been precipitated by the low prices of the previous year. The even lower prices of the current year will mean even lower production in 2017. Current oil production has nothing to do with current oil price. There is a considerable lag time even for shale, let alone tar sands, offshore or conventional oil. If fresh billions of dollars are currently flowing into the US shale industry then they are only covering current (and shrinking) operations and debt repayments, because investment is still shrinking at a rapid clip. The rig count has collapsed into multi-decade lows. The fracklog that lots of shale cheerleaders love to point to, doesn’t mean that those wells are ready to produce whenever WTI reaches a certain threshold. The biggest cost of an oil well is its completion, not its drilling, therefore massive investments will be needed for the fracklog to be brought into production. Moreover, many of these drilled but uncompleted wells may be located in geological formations that are far from lucrative. Only wells found in the so called “sweet spots” can be touched at the current price environment.

No one said “immediately.” Things do take a little time. Here’s proof that it will happen: Drillers are hedging their production at $45. They’re going to deliver. And to do that, they’re going to produce.

US natgas has been through this since 2010….

This is NOT what I want to happen. This is what I see happening. And this is bearish for a real oil price recovery.

walter map

Apr 28, 2016 at 9:04 am

“Old investors get wiped out, new investors line up…”

New investors get wiped out.

The triumph of hope over experience. How about if I just watch from a safe distance, thank you. I just don’t see adquate pricing to be sustainable in the face of such a sustainable glut.

MC

Apr 28, 2016 at 5:30 am

But the question is simple: how long can commodity prices be manipulated before blowing off again, and in bigger fashion? We’ve seen early last year and we all know how well it ended.
Differently from stocks, commodities are still somehow tied to fundamentals: in the oil markets it takes the form of Chinese strategic reserves at over 80% capacity and a dearth of VLCC’s, as most have been hired to act as floating storage capacity in the Gulf or off Quingdao.

If last year is anything to go by, May will be the month of truth, albeit the oil market is still way too US-centric: a minuscule variation at Cushing affects prices far more than record production from Russia and Iraq, or Libya’s decision to open the taps a bit more (don’t ask me which Libyan government legislated to this end). This is one of the coming corrections that will hit hard. In a global economy with major consumers such as China or India and major producers such as Russia and Iraq a single market cannot be used to set prices worldwide. It can influence them, heavily, but not being used as the sole benchmark.

On an aside, it seems the lambs are being led to slaughter once more: pension funds have been loading up on energy stocks. Yes, right now, when even Exxon-Mobil lost its 80+ year old AAA rating and when oil is wildly swinging (yesterday it was quite a ride).
The stocks this subset of institutional (whose asset managers should be institutionalized) have been buying hand over fist are being dumped with abandon by the ultimate “smart money” in one of the longest sell tally in recent memory.
Like Canadian snowbirds, hedge funds and PE firms are cashing in their chips and going into hibernation while sitting on a big pile of cash.
See you again this Fall, folks!

James McFadden

Apr 28, 2016 at 10:06 am

@MC
Can you point to the info that PE is “cashing in their chips” on the oil patch and “sitting on a big pile of cash”? Everything I read suggested that PE was investing in oil all last year – and those junk bonds must have gone south since that time. Since PE is chasing returns in the age of ZIRP, they continue to invest in the riskiest ventures to maintain the short term illusion of profits so they can keep skimming off their fees from the sucker pension funds. Nakedcapitalism writes extensively about this. PE can’t maintain this illusion, and their fees, if they pull out of the junk bond market and take a big loss – so I would suspect they are staying the course — an illusion like the banks maintained with foreclosed houses so they did not have to book the losses.

DS

Apr 28, 2016 at 6:11 am

Technological progress coupled with circa half a trillion USD that was lost producing that tremendous amount of oil.
They’d do better by paving the nevada desert with solar panels. At least it would be a recurring source of energy.

walter map

Apr 28, 2016 at 5:23 pm

“They’d do better by paving the nevada desert with solar panels.”

Big Oil would never allow it. Libya was gearing up to do that and look what happened to them.

Thomas Malthus

Apr 28, 2016 at 8:14 pm

While on the topic if the saviour – solar jesus… consider this:

If the state of California converted to 100% solar electricity here’s what would happen:

– you would have no electricity during the time that the sun doesn’t shine.

– if you wanted to have electricity during the evening and night then you’d have to build the infrastructure to produce that electricity – it would need to be at least as productive as your solar because peak use hours for electricity are evenings.

– so you’d have to complete production systems increasing your costs massively and you’d end up with some of the biggest electricity bills the world has ever seen.

Solar Jesus…. right… let’s see what George Carlin had to say about such things ….

Distributed grid energy storage is coming. For all night. I’ve seen it. Not batteries. Not weighted rail cars. Beats pumped hydro, can be set up anywhere, but too large-scale for the backyard. But, it is distributed and cheap. That is key.

Already, on March 27th, 2016, the ISO in California told a solar farm to shut down 100%. Too much electricity in the system, and solar is the easiest to disconnect.

Timothy Julian

Apr 28, 2016 at 7:32 am

There are many horrific stories coming out in the U.S. about pollution side effects & fracking. However, the point your miss Wolf, is how old these Russian/Saudi/Iran fields are. The Russian/Saudi fields are at least 50+ years, they are about to go into serious declines. Russia cannot go on producing 10mbd for much longer. The U.S. knows this.

The price of oil is going to go through the roof in the coming years. I doubt very much whether oil is going very much below these levels. I think it is slightly ignorant to ignore the age of many oil wells. Just look at the UK & North Sea output. By 2020, the UK will only be producing 1/3 of the output itb did in 99.

robt

Apr 28, 2016 at 10:20 am

Just find more. In 1980, the analysts, as reported in the newsmagazines, forecast that we’d be out of oil by 1987. All they did was divide reserves by consumption to arrive at the answer, completely overlooking the fact that reserves are like inventory to a retail business. Would a retailer be expected to have 100 years inventory in stock or go out of business if it didn’t? What would their cash flow look like?
A few years ago, Goldman Sachs forecast 200 dollar oil due to shortage.
The truth is, we’ve never come close to running out of oil despite orders of magitudes of increase in consumption, and in real terms the price is half of what it was over 100 years ago despite the onerous taxes imposed by governments and the kleptocracy of producing countries.
And just to dispel the myth of the big bad oil companies, when the Big Oil producers controlled most of the production in the world, the price stayed at about 2 bucks a barrel for over 60 years after the evil Rockefeller brought the price down from 80 in the latter part of the 1800s to 2 dollars.
And gasoline? It was 15 cents a gallon 100 years ago (eq. 6 dollars today), and vehicle MPG consumption was double.

ERG

Apr 28, 2016 at 9:34 am

Yet another manipulated commodity price – oil – with the sole intention of saving the collective asses of the banks that made the loans to that business sector in the first place. There’s no reason on Earth why crude should be in the $40s given the present economic environment. Did a whole bunch of supertanker captains catch a cold or something? This is only more business as usual: extend and pretend.

Nicko

Apr 28, 2016 at 10:19 am

The new Saudi King has big plans to transition his country away from oil dependence, only time will tell if the massive reorientation proves a success —but Saudi certainly has the cash to try.

Petunia

Apr 28, 2016 at 10:44 am

The Saudi’s have been drowning in cash since the 70’s. You would think they would at the very least invest in R&D in their own industry, but they haven’t. All the innovation in drilling is in the US, as has been stated on this blog. The Saudi’s still have no meaningful infrastructure, no cutting edge medical care, nothing worth noting. What makes you think they will reorient now? Something tells me, when the cash stops, they will go back to camel herding in the desert.

Coaster Noster

Apr 30, 2016 at 6:33 pm

They tried wheat farming on a massive scale. Finally gave up.

Yoshua

Apr 28, 2016 at 12:26 pm

I have read that the OPEC producers have decided not to hedge their production with derivatives.

night-train

Apr 29, 2016 at 2:40 am

Those bullish on recovering high oil prices should follow through with investment. When it comes to the US Shale plays, I am all for charitable giving, but I can find far more deserving charities.